Section 365(n) of the United States Bankruptcy Code (11 U.S.C. Title 11) protects the rights of intellectual property (IP) non-debtor licensees.  Section 365 of the Bankruptcy Code allows a debtor –in-possession, or a trustee (e.g., a software vendor) to: (a) assume, (b) assign, or (c) reject certain executory contracts – which would typically include software licenses.  A debtor in possession’s decision to assume, assign, or reject an executory contract is subject to court approval, certain deadlines and other requirements detain Section 365 of the Bankruptcy Code.  Section 365(n) is a carve-out to that broad right that allows a non-debtor counterparty (e.g., a licensee in a software license) the right to either accept the rejection of the license or continue performing under the contract for the duration of the term of that license. 

If the software vendor assumes a contract despite the bankruptcy, both parties can continue to perform their obligations as if nothing had happened.  If the software vendor assigns a contract, the assignee will perform the software vendor’s obligations under the license.  However, if the software vendor rejects the license, the licensee can either accept the rejection or retain its contracted-for rights and continue to use the software for the remainder of the term of the contract.

However, in the context of a software license, the licensee may not be able to continue to use the software without access to the source code and without the assistance of the licensor. Given the unique nature of software licensing agreements, licensees must assess the risks of a vendor going bankrupt, understand the rights and remedies afforded under 365(n), and implement strategies for gaining access to source code to continue to maintain the software. 

Key Points in Drafting Software License Agreements:

  • License Should Be Explicitly Subject to 365(n): The software license agreement needs to include language that it is subject to Section 365(n) of the Bankruptcy Code.  While not dispositive, explicit language makes the intent of the parties clear.
  • Source Code Escrow: Because licensees only retain rights that exist at the time of the bankruptcy, licensees need to make sure that the software license agreement includes the right to access source code and any associated support and maintenance rights to use that source code.  Robust source code escrow agreements and carefully drafted escrow provisions are critical to retaining maximum flexibility and use of the software on a going forward basis – even if the software vendor goes bankrupt.  Having continued access to the software, but no means to maintain or update it, does little good.
  • Separate Licensee Fees from Other Fees:  License agreements often contain payment obligations for (among other things) support, professional services, software development, maintenance, and customizations that are not associated with the license grant.  If these fees are bundled together, a licensee may be obligated to continue to pay fees for services not provided – just to continue to access and use the software.  Delineating licensee fees from other fees minimizes this risk.

Carefully drafting license agreements to account for the potential of a software vendor bankruptcy is critical to achieving maximum flexibility in using licensed software and minimizing business disruption.